Download Guidance for Reimbursing Employees` Business Expenses

GUIDANCE FOR REIMBURSING EMPLOYEES’ BUSINESS EXPENSES
Most companies cover their employees’ business expenses by reimbursing them for their
actual expenses or paying a travel or mileage allowance. Such arrangements are subject
to strict tax rules concerning what qualifies as a legitimate reimbursement arrangement
and what is treated (at least for tax purposes) as additional compensation to the employee.
According to the tax rules, the key distinction between a true expense reimbursement and
disguised compensation is whether the employer’s payments are made in accordance with
what the IRS calls an “Accountable Plan.” Such a plan basically requires employees to
substantiate all reimbursed expenses and return any advances in excess of expenses
incurred.
If an employer has an accountable plan in place, expense reimbursements and allowances
to employees who properly comply with the terms of the plan are deductible by the
company and non-taxable to the employees. If a company maintains a non-accountable
plan or an employee fails to comply with the company’s accountable plan, expense
reimbursements and allowances are still deductible by the company. However, they are
taxable to the employee as compensation.
An accountable plan must satisfy several requirements as follows:
•
Business Connection: The plan can provide reimbursements or allowances only
for otherwise deductible business expenses such as travel, lodging, or meals
incurred while away overnight on business that are paid or incurred by individuals
in connection with their performances of services as employees for the employer .
The reimbursements and allowances must be clearly identified as such when the
employee is paid (for example, by paying them in separate checks or by
specifically identifying the reimbursement or allowance on the check stub if it
includes wages).
•
Substantiation: The plan must require a substantiation of the expenses being
reimbursed through the use of an expense report, diary, log, trip sheets or similar
records. The purpose of this record is to identify the specific nature of each
expense and to allow the employer to conclude that the expense is attributable to
its business activities. In addition to these general requirements, for travel,
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entertainment, gifts, and property such as computer used in a home office or an
automobile, a receipt or other documentary evidence is required if the expense is
$75 or more or if it relates to lodging. This documentary evidence should
substantiate (1) the amount and business purpose of the expense, (2) the time and
place of any travel or entertainment, (3) the date and description of any gifts, and
(4) the business relationship to the company of each person entertained or
receiving a gift.
If an employer provides expense allowances, an allowance that doesn’t exceed the
federal rate is treated as meeting the substantiation requirement and is considered
paid under an accountable plan, with respect to expenses incurred for which the
allowance was paid. If an allowance exceeds the applicable federal rate, the
excess does not meet the substantiation requirements for the related expenses.
Thus, such excess is deemed paid under a non-accountable plan and is subject to
income tax withholding and payroll taxes as additional compensation.
•
Return of Excess Advances: The plan must require employees to return any
advance that exceeds substantiated business expenses. Any excess not actually
returned should be treated by the company as compensation to the employee and
is subject to income and payroll tax withholding like any other compensation.
A plan need not require employees to return the portion of an expense allowance
that exceeds the federal rate for the days of business travel or business miles as
long as such travel and miles are adequately substantiated with respect to
everything but the amount of the actual expenses. However, as discussed above,
such excess does become wage income to the employee.
As long as an employer’s expense allowance does not exceed the federal rate, employees
may retain any excess allowance (“keep the change”) for days of travel or business miles
substantiated without disqualifying the accountable nature of the employer’s plan. In
contrast, plans that reimburse actual expenses must require employees to return all excess
advances.
Please note that there is a reasonable time period requirement for both the substantiation
of expenses and the return of any excess expenses. Generally, a facts-and-circumstances
approach determines what constitutes a reasonable period. Thus, an employees goes on
an extended travel assignment would have a longer period to substantiate expenses and
return excess amounts than an employee whose travel consisted of a single overnight trip.